If you ask around about Free Cash Flow you will find at least one person who thinks it’s a huge money giveaway. Don’t laugh just yet… some people do! The truth is, most business owners can tell you in less than a second how much is their current net profit, but only a few are aware of their free cash flow situation. Why is that? For starters, many of them think it’s the same thing. Others have never even heard the word before. Yet FCF is important for your business if you need to know exactly how much cash you have available. How is that different from your net profit? Net income is the profit a company has earned for a certain period. In other words, the revenues recognized less the expenses recognized in a reporting period. Cash flow, on the other hand, measures the cash going in and out during a company’s day-to-day operations.
So, how can you calculate your free cash flow? Very easily, indeed. Net profit is the starting point in calculating your cash flow. You take your net profit, which I believe you know very well (at least, you should!), and then to this figure, you add the paid taxes and the paid interest expenses on any loan. To that figure, you add in any non-cash expenses (e.g. amortization & depreciation).
As you can see, we are simply adding the expenses that involve no cash going out of the business and deducting from that the actual payments that you made for new capital assets. And why is this important? Because this is the money that you have available for your business, and generally and if your business is in good health, it should be more than your net profit. If you are not aware of your FCF, you may postpone or even give up good investment opportunities, just because you think that you don’t have enough money or cannot afford a business loan. As a result, your future growth may suffer. So, yes, I would say that FCF is very important indeed.
Julio is the owner of a dry-cleaning business and he needed to buy new machines because the demand for his services was increasing. However, he thought he didn’t have enough money to pay the loan needed to buy the equipment. He asked me for help because he wanted to grow his business, but he wasn’t sure where to start. When I asked him about free cash flow, he went blank! I explained Julio the basics of FCF and we started crunching numbers. It turned out that his net profit is around $23,000 a year. Since the bank calculated monthly payments of $2,000 on a business loan (making a total of $24,000 annually), Julio thought he could barely make it and was ready to give up on the loan that could grow his business. But, after calculating his FCF, which in his case was around $34,000 per year (way above his net profit!), he realized he could afford to pay comfortably up to $2,500 a month, so he was on the safe side while taking the loan. Needless to say, he went ahead with his application.
Is your situation similar to Julio’s? Then make sure you know your free cash flow! The good news is, you don’t need a personal advisor to help you crunching numbers to arrive at your free cash flow. All you have to do is visit this article where you can learn how to calculate your free cash flow in 4 easy steps. Remember: as a business owner, your main job is not only to make decisions but to make well-informed ones. Lack of information means poor decisions that translate into lost opportunities and stagnant business. So, get your free cash flow numbers straight: it’s the first step to take control of your business and make it grow!
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